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Five Ways Diageo plc Could Make You Rich

diageoDiageo (LSE: DGE) (NYSE: DEO.US) has been hit harder than most by the panic over emerging markets — the global drinks giant’s share price is down 8.3% so far this year, compared with the FTSE’s mere 1.6% drop in the same time. 

But here are five ways that Diageo could still make you rich.

1. Because current worries are overdone.

After a spirited few years, some kind of hangover was inevitable. The current headache comes courtesy of the wobble in emerging markets, where the company generates 50% of its earnings. Yet much of the sales slowdown can be pinned on specific issues, such as the crackdown on gifting to officials in China and political upheavals in Thailand. Total emerging market sales still rose 1.3%, according to its latest half-year results. And there was better news in the West…

2. By being well diversified.

Investors saw Diageo’s emerging market exposure as a strength during the financial crisis, because it offset weakness in developed markets. That global diversification is equally valuable today. Falling sales in China and Thailand were offset by a 5% rise in US spirits, its biggest division. The benefits will become yet more apparent if the US and Europe continue to recover. This is exactly what diversification is designed to do. I’d be more worried about SABMiller, which has 85% exposure to emerging markets.

3. By heading upmarket.

Diageo’s net sales grew 1.8% in the first half, but this was overshadowed by an 18.5% rise in sales of its reserve brands, with its super and ultra-premium brands also growing strongly. Sales of reserve brands Ciroc, Bulleit, Ketel One vodka and Johnnie Walker leapt 26% in the US, which appears to validate new chief executive Ivan Menezes’ Drink Better strategy. The company has also shown it still has the will to innovate, with brands such as Ciroc Red Berry, Smirnoff Gold and Baileys Chocolat Luxe driving sales in the UK. With average wage growth sluggish, but the wealthy getting wealthier (and keen to show it), heading upmarket looks like the right strategy to me.

4. Because it’s getting cheaper.

One problem I’ve had with buying FTSE 100 stocks lately is that too many have looked fully valued. Diageo was certainly one, because it has been trading at close to 20 times earnings for some time. But could a buying opportunity be approaching? Absolutely, with the share price around 8% in the past three weeks. Now you can buy it at a little more affordable 17 times earnings. This has also bumped up its (traditionally rather weak) dividend, which now yields 2.7%. The recent 9% increase in the interim dividend will help on that front.

5. By emerging stronger from recent troubles.

There’s no disguising the fact that net sales fell 1% in the first half, and earnings per share (EPS) are set to fall -1% in the year to June 2014. But management is working hard to add a little fizz, improving margins and operating profits. Plans to de-layer Diageo and deliver further operating efficiencies should help, with planned savings of £200 million a year, which should release money to boost growth and margins. EPS are set to rise to 9% in the year to June 2015, lifting the yield to a forecast 3.1%. Diageo may be troubled in the short term, but in the long term it should help make you rich.

But if dividends are your thing, you can get double the yield by investing in some FTSE 100 stocks, you just need to know where to look.

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Harvey Jones owns shares in Diageo plc. He doesn't own shares in any other company mentioned in this article